Sole Proprietorship: A business with one owner (and is not a taxable entity)
Partnerships: Owned by two or more individuals (also not a taxable entity)
Non-business entities: organized for a purpose other than earning a profit
Economic Entity Concept: Assuming that everything is accounted for in a business. Personal costs must
be separate from the business.
Operating Activities: “Day to day” activities
Investing Activities: Purchase and sale of long-term assets
Financing: Money needed to start a business
Retained Earnings Equation: Beginning RE + Net Income – Dividends = Ending Retained Earnings
Cost Principle: Assets are recorded at the cost to acquire them
Going Concern: That a company will continue to operate in the near future
4 Fundamental Financial Statements
1.) Income Statement
a. Reports the results from Operations in a specific period of time
b. Revenues, expenses, and Net Income/Loss (Part of “performance”)
2.) Balance Sheet
a. Shows the financial position of the company up to date
b. Assets, Liabilities, and Shareholders’ Equity
3.) Cash Flow Statements
a. Shows the movements of cash and cash consequences of transactions by the type of
activity for a period of time.
4.) Statement of Retained Earnings
a. Shows the changes in retained earnings for a specific period of time (format similar to
Income Statement => Statement of Retained Earnings => Balance Sheet => Cash Flow Chapter Two
Characteristics that make accounting information useful:
o The quality of accounting information that makes it comprehensive to those willing to
spend the necessary time.
o The capacity of information to make a difference in a decision
o The quality that makes accounting information dependable in representing the events
that it purports to represent
o Allows for comparison to be made between or among companies
o Allows a user to compare 2+ accounting period for the same company
o The impact of a mistake in the financial statement that will impact a user’s decision.
The Classified Balance Sheet:
- Operating Cycle: the period of time between the purchase or inventory and the collection of any
receivable from the sale of the inventory
- Current Assets: Assets that’s are going to be used or consumer within one operating cycle or
o Cash, A/R, Inventory, Temporary Investments, prepaid cash (prepaid anything)
- Non – current Assets: To be used or consumed in more than a year
o Investments, Plant Property and Equipment, Intangibles (Trademarks, copyrights)
Depreciation is the term used to tangible assets. Amortization is used for intangible assets.
- Current Liability: An obligation that will be satisfied within the next operating cycle or one year.
- Shareholders’ Equity: Owner’s claims on the assets of the business
o Contributed Capital: Capital Stock (Common Stock)
o Earned Capital: Retained Earnings
Liquidity: The ability of a company to pay its debts as they come due.
Working Capital: Current Assets – Current Liabilities Working Capital:
- Too little: may signal inability to pay creditors
- Too much: Could indicate that the company is not investing enough into itself (i.e. for new
Current Ratio: Current Assets/Current Liabilities (allows us to compare liquidity)
The Statement of Retained Earnings
Beginning Retained Earnings + Net Income – Dividends = Ending Retained Earnings (Net Income on
income statement is addition to Retained Earnings)
The Statements of Cash Flow
1.) Operating Activities
a. Involves the purchase and sales of products and services
b. Day to day activities
2.) Financing Activities
a. Money needed to start a business
b. Involves the issuance & repayment of long term liabilities and capital stock
3.) Investing Activities
a. Acquisition of long-term assets
b. Long term investments, Triple P’s, Intangible Assets Chapter Three
External Events: Involves an interaction between the entity and it’s environment (such as payment of
wages to an employee)
Internal Events: Occurs entirely within the entity (The use of a piece of equipment)
Source Documents: A piece of paper that is used as evidence to record a transaction (Receipt, invoice)
Types of Transactions
1.) Issuance of Capital Stock
a. Increase Cash
b. Increase Capital Stock
2.) Purchase of Equipment (Cash & note)
a. Decrease Equipment
b. Decrease Cash
c. Increase A/P
3.) Prepayment of Rents
a. Increase Prepaid Rent
b. Decrease cash
4.) Sale of Day Passes (I.e. for gym)
a. Increase Cash
b. Increase Revenue
5.) Rental of space (with promise to pay)
a. Increase in A/R
b. Increase in revenue (rental revenue)
6.) Sale of Annual Memberships
a. Increase in Cash
b. Increase in Unearned Revenue
7.) Payment of Salaries & Wages
a. Decrease in Cash
b. Decrease in Retained Earnings
Cost Principle: Requires that we record on asset at the cost it is acquired. Chapter Four
Recognition: Process of including an item in the financial statements of an entity
Historical Cost: “Original cost”. The amount paid for an asset.
Realizable Value: “Current Value”. The amount of cash you can receive today for selling it.
1.) Prepaid Expense (you pay the cash before the expense comes up)
a. Prepaid Rents (Understand that an asset decreases and an expense increases)
i. Dr. Rent Expense
ii. Cr. Prepaid Rent
b. Depreciation (Contra-Asset, which means transaction it opposite of that of a normal
i. Dr. Depreciation Expense
ii. Cr. Accumulated Depreciation
2.) Unearned Revenue (You get the cash before the work is done)
i. Dr. Unearned Revenue
ii. Cr. Rent Revenue
3.) Accrued Liability (You have an expense you didn’t pay yet)
a. Usually for wages
i. Cr. Wages Payable
ii. Dr. Wages Expense
4.) Accrued Revenue ( When you have done/given a service, but still need to receive the cash)
a. For rent and interest (from the providers POV)
i. Dr. Rent Receivable
ii. Cr. Rent Revenue
Chapter Five Revenues: Increases in economic resources. Revenue comes from sale of goods, or rendering of services.
Revenue Recognition: Revenues are recognized when they are earned:
Performance is Achieved
Amount is measurable
Collection of cash is assured
Manufacturing Goods & Merchandise: Revenue is recognized using time-of-sale method
Long-Term Contracts: Recognized using percentage – of – completion method. It recognizes revenue
over the life of the project, instead of just the end.
Franchises: Recognizes revenue from the franchise fees, equipment sales, and royalties.
Commodities: Recognized using the production method. It is recognized when it is mined because it is
interchangeable with another (i.e. gold can be exchanged for another gold). Revenue is recognized
before the sale takes place.
Installment Sales: Revenue is recognized using the installment method. Revenue is recognized after the
sale takes place and is essentially the cash basis of accounting.
Rent & Interest: Earning takes place with the passage of time
Matching Principle: Matching the revenue with the expenses for that period.
Direct vs. Indirect Matching:
o COGS Expense with revenue
o Usually long-term assets
o Buildings, property plant and equipment
- Single Step
o Benefit: simplicity
o All expenses are added together and subtracted from Revenues
- Multi Step
o Shows Revenue, Expenses, and important subtotals
o Shows gross profit (Revenue – COGS)
Chapter Six Specific Identification
- Specifically identify which units are sold, and which units are on hand. An inventory costing
method that relies on matching unit costs with the actual units sold.
- Two techniques to find out COGS
o 1.) Deduct ending inventory from COGS available for sale
o 2.) Calculate COGS independently by matching units sold with their unit costs.
Weighted Average Cost Method
- Assigns the same unit cost to all units available for sale during the period.
- Cost of Goods Available Fo